Two New Year’s Resolutions

by Dr. Gary North
Date 1/5/2009 • Issue 42

Every year, from late December through the first week of January, there are lots of articles published on making New Year’s resolutions. Some of these articles recommend New Year’s resolutions. Other articles make fun of them. The authors point out the obvious fact, namely, that almost nobody ever follows through on a New Year’s resolution.

I am in the camp of the skeptics. I do not believe that most people will follow through on any resolution, let alone a New Year’s resolution, unless there are enormous positive benefits to be secured by following through. People think about the benefits, but then the cost of obtaining these benefits becomes obvious in the first week after New Year. The cost of the benefits is immediate, while the benefits themselves are far in the future. The tyranny of the urgent conquers the hope of the future.

We all know this, but we are tempted to make New Year’s resolutions anyway. This is the triumph of hope over experience. The trouble is, people become discouraged early, and this discouragement lasts for as long as the New Year’s resolution had specified. The only way to escape, other than actually getting back on track, is to self-consciously stop thinking about the New Year’s resolution. This tends to produce guilt. People conclude that they are unable to follow through on long-term plans, and so they are tempted not to make any long-term plans.

The problem with New Year’s resolutions is that they are not part of a systematic plan. The resolutions have no plan undergirding them, and they do not fit into an existing long-term plan. The main reason for this is that very few people have made existing long-term plans. They do not write down their goals, nor do they write down a plan to achieve these goals. This is a mistake that almost everyone makes, and it keeps most people from achieving their potential.

The Bible has an entire chapter devoted to the question of vows made to God: Numbers 30. It has rules regarding these vows. These vows are voluntary, and they are not to be entered into lightly. Once made, they are to be fulfilled. This is why it is unwise to make a formal vow unless you’re willing to pay the price of fulfilling it. The obvious one is the marriage vow. There are others.

I do not put a New Year’s resolution in the same category as a vow made to God. But there is a pattern here. We live in a society in which contracts are violated, vows are violated, and New Year’s resolutions barely make it to February.

PAYMENT OFF THE TOP

I do have a recommendation for a New Year’s resolution. In fact, there are two resolutions, and they are interlinked. The first resolution I call “pay God first.” The second resolution is called “pay yourself second.”

“Paying God first” is your tithe. It comes first. Find some way to pay it. If you can set up an automatic withholding plan at work, do this. Have the money deposited in your church’s account. Talk with your payroll person and your church on how to do this.

The fact that churches do not recommend this in new members’ classes indicates that they are in begging mode. Churches should make it easy for people to meet their obligations.

The phrase, “pay yourself first,” is a familiar one inside the personal finance industry. The idea of paying yourself first is based on a view of thrift. This view says that it is imperative that a person take 10%, or some other fixed percentage, of his after-tax income, and invest it. No matter what takes place, no matter what emergency arises, an individual self-consciously takes 10% of his income after taxes, and invests it.

Why do people call this “pay yourself first”? They do this because they understand that an individual owes something to himself. He owes in the present what it will take to sustain him in the future. His present self owes his future self.

Why does he owe this? Because he is personally responsible for his own actions. He will require savings in the future in order to sustain them in his old age, or when an uninsurable disaster strikes. So, he is careful to set aside money every month to invest in a systematic program that will meet his needs in the future. He does this because he does not wish to become a burden to other people. He does not want to become a charity case.

Another aspect of “pay yourself first” is that at some point, compound economic growth is supposed to take over. The resources that have been set aside for future use begin to generate a return on investment. Over time, this return multiplies the value of the investment portfolio. This is called putting your money to work for you. The stream of income feeds back into the total portfolio. This stream of income multiplies over time, and the individual finds that the end of his life, he does not have to work in order to build capital. The capital produces sufficient income to maintain his lifestyle whether he works or not.

This has been the promise of IRA programs and 401(k) programs for two decades. The problem is, because of the nature of the investment markets in a world governed by the central bank policy, inflation, bad investments, and government promises of bailouts have combined to reduce the rate of return on capital. This has made it difficult or even impossible for the vast majority of people who have set up retirement programs that will enable them to retire in comfort on the income generated either retirement portfolios. They have believed government promises about protecting the small investor, and they have therefore lost a great deal of money. Even worse, they have lost a great deal of time. The longer that they remain naive about the nature of economic returns in a world governed by central banking, the less likely they will be in a position to live off of the income generated by their investment portfolios.

What good is it to pay yourself first? If all of your savings will be eroded by monetary inflation and the business cycle, what good is it to save? This depends on what you invest the money in. If you invest in assets that tend to rise with the rate of price inflation, you can stay ahead of the monster. But there is something else that is even more important. It is crucial that an individual take the attitude he is responsible for his own future. If he does this, he will adopt a system of thrift, whether the money goes into conventional markets or whether it goes into the family business. The point is, the individual recognizes that the future does not take care of itself; it requires planning and the proper execution of the plans in order to achieve a major goal, such as retirement.

It is the self-discipline of setting up goals, establishing a plan, and maintaining the plan that is crucial for success in life. It is far less important what an individual invests in an effective the invests on a systematic basis. It is the constant attention to detail, and the constant exercise of self-discipline, that is crucial for long-term success. It is the mental habit of saving on a regular basis, no matter what, that makes the difference in an individual’s productivity. The habit of saving, which rests on the habit of deferred gratification, pays dividends apart from on investment portfolio. This attitude begins to affect all aspects of individuals life or he this is what makes the big difference for him in the long run.

I recommend to people that people adopt this self-discipline early in life. I taught my children to tithe 10% of their income and save 10%. As adults, they are all extremely thrifty, and they all have maintained a savings program. They understand that they are personally responsible for their old age, and they also understand that the Federal government is going bankrupt. They understand that no official is going to intervene on their behalf when they are old and weak, and therefore they do what they can to build assets to protect themselves in the future.

Thrift is more than an systematic program of investing. It is a mental attitude regarding the future. This attitude takes full responsibility. It does not attempt to blame the government for the government’s failure to protect the public from their own lack of self-discipline.

TWO PARTS

This is why I recommend a two-part New Year’s resolution. First, you promise yourself to pay 10% of your gross income to your local church. You do this because it is not your money. This is a kind of return on investment for God. It is comparable to a licensing fee paid by individual companies that are part of a franchise.

By paying yourself second, you acknowledge that you cannot be sure about the future. You build up resources that can be used at a time of your life when you will not be able to support yourself. Your lifetime plan has to have some consideration of the fact that you will grow old, and you will become less able to earn a living. This faces the fact of ageing: old age does reduce most people’s productivity. Acknowledge this early if you are going to enjoy a decent lifestyle in old age.

In past eras, the vast majority of people lived their lives on the assumption that their children would take care of them in some way. Welfare state economics has undermined this ancient assumption. This is temporary. When Medicare and Social Security go the way of all flesh, the older tradition will again manifest itself in the American public.

We live in a temporary period of time in which people have naively believed that they will be able to save enough money, and also gain a large enough after-inflation, after-tax rate of return to gain sufficient wealth to provide a comfortable retirement. That illusion has been challenged over the last 14 months. It will be challenged again. The stock market is not going to deliver the goods.

I recommend to people that they systematically save 10% of their income every month, or every paycheck, as a kind of liturgy. It is a liturgy acknowledging the stages of life. It is a reminder that the clock is ticking. As a self-defense measure against the ticking of the clock, an individual sets up a savings program to which she contributes on a regular basis.

I think the best way for most people do this is to set up an automatic savings-withdrawal program through their job. It does not matter much what the money goes into initially. It can go into a bank account. The important thing is that the individual not get used to spending this money, and therefore not become dependent on it. He transfers it automatically to a thrift program. He adjusts his expenditures to work around his income, which is then reduced by whatever he has set up in his savings-withdrawal program. This is a form of resolution that has teeth. The reason why it has teeth is that most people cannot feel the bite. The money comes out of paycheck, but people do not become dependent on it, nor do they really miss it.

The United States government caught onto this when it imposed withholding taxes in 1943 as a wartime measure. Tax revenues quadrupled within a year. I suggested this is one of the few lessons that the government has ever provided that can seriously benefit the public. The principle underlying the success of the withholding program is this: “Out of sight, out of mind.” It is the opposite of this: “Absence makes the heart grow fonder.”

If you want to be successful with a New Year’s resolution, make sure that the New Year’s resolution has teeth. The best possible teeth are teeth that take their bite quietly and painlessly.

The first few months of a savings-withdrawal program will be extremely painful. Adjusting to a lower income is difficult for almost all people. This is why it is so important that people begin early in life with the savings withholding program. They must not get used to the income their job generates. The transition is always painful. This is why people postpone making it. But if the pain is not experienced early in life, it will be experienced later in life. It is better to experience an early in life, when you have the strength, resiliency, and youth to adjust. You don’t want to be forced into adjustment when you’re 80 years old.

If you are serious about this particular New Year’s resolution, on Monday morning, you will contact whoever is in charge of payroll at your company. Ask that person to set up your account so that the computer begins extracting money on a regular basis. This will be put into a savings program. This may be a tax-deferred program such as an IRA, or it may be some other form of savings. The important thing is that it is automatic. Your goal here is to reduce your dependence upon your income in the present for the sake of the future.

CONCLUSION

The best plan is an automatic plan. You don’t have to think about it. You set it up once and live with it.

A combined 20% reduction of income is too big for most families’ budgets. There are two ways to handle this. The best way is to get a second job until the 20% limit is met. The second-best way is to cut expenses, while adding one percentage point per month to the tithe. Only when the tithe is met does the savings-withdrawal program get activated. Pay yourself second.

You will have to decide where the money goes after it arrives in your bank account. This will force you to pay attention to the economy. But this should be a separate issue. The crucial issue is setting up the automatic withdrawal plan.

 

The Federal Reserve and Inflation

The Federal Reserve Is Inflating at 341% per Annum. (Don’t Look for the Decimal Point.)

By Dr. Gary North (Originally Found on www.garynorth.com)

October 24, 2008

I have never seen anything like this. The adjusted monetary base over the last eight weeks has risen at 341% per annum. The increase in the monetary base is $300 billion

This indicates panic at the Federal Reserve. The financial system is coming unglued.

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The monetary base is high-powered money. For every dollar injected here, the money supply can rise by at least 10 to one. A 10% reserve requirement is imposed on large urban banks, i.e., a 10-to-1 multiplication factor. This is the fractional reserve banking process. This is from the Federal Reserve’s site.

The recession is pushing down the price of commodities. So far, the new money has gone to banks and financial institutions. They are not lending to businesses. They regard businesses as too risky. This is getting a lot of press.

 

http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=amZ3uCIUB8GQhttp://blogs.wsj.com/economics/2008/10/17/will-banks-lendThese articles never mention the obvious: the banks can lend at any time. They make no money if they don’t. They can buy Treasury debt. Central banks do. So can commercial banks. This explains why Treasury rates have not increased, despite the increase in the Federal debt. 

The Federal government spends every dime it borrows. This money will flow into the economy by way of Washington. This money will not be lent to private businesses. It will not re-capitalize the country. How can it? It is not saved capital. It is fiat money.

If the banks are not lending at all, the monetary base sits there, ready to be used by the banks. At the first sign of economic recovery, they will start making loans. The money multiplication process will take over.

If this expansion of the monetary base does not stop, it will create mass inflation when the banks begin to lend (assuming they aren’t lending to the government now).

To stop it later, the FED can sell assets to shrink the monetary base. Which assets? Toxic waste loans? Who is going to buy them? Who wants toxic waste assets in the any stage of the recovery? It can sell Treasury debt, but only until it runs out. It has a little over $450 billion remaining.

 

http://www.cumber.com/home/Factors.pdfIf the banks will not lend at all, then the FED is “pushing on a string.” But why won’t they lend? They are legally allowed to. Why borrow in the federal funds market if you have legal reserves? Yet banks are borrowing in this market. They borrow because they have no reserves remaining.Banks can buy Treasury debt, which is liquid. The debt pays some interest. Something is better than nothing. Not to buy Treasury debt is to throw money away. Banks do not throw money away. Banks buy Treasury debt; the government spends it. Businesses seeking loans find that they must pay higher interest, because the Treasury gets the money. So, the government’s share of the economy grows. This reduces productivity. An economy in a recession needs productivity to get out of the recession. 

The fractional reserve process takes over. The money supply grows. We can see this happening now. Here are the latest M1 statistics. You can see that the figure is headed straight up after years of being flat.

Alert anyone you think should see this. Email this page. People can monitor these statistics free of charge on www.garynorth.com. Go to Federal Reserve Charts and Yield Curve, which are in the Free Materials section of my site.

 

The Whiners and Their Thug: Congress

By Dr. Gary North 
for Gary North’s Q&A forums: www.GaryNorth.com

Last week, former Senator Phil Gramm, an economic adviser to John McCain and a Ph.D. in economics, assessed the present state of American voters’ opinion regarding the economy. He called them whiners.

The press immediately went ballistic. How could he have said such a thing? Shame! Shame! McCain quipped that Graham was high on his list to become ambassador to Belarus.

Graham was correct. Americans are the richest people in history. The economy has barely slid into economic recession.

Yet they are complaining of a heavy burden. They haven’t a clue of just how heavy this burden can become, and how fast.

Americans are like small children who fall down and scrape their knees. They want Mom to make it all well. Mom is the Nanny State.

When the economy is in an extended recession, as it will be, what will voters do? What pressure with they put on Congress to solve the problem? What will Congress do?

We know what it will do. It will spend. It will regulate.
It will go looking for victims.

It already is.

PROSPERITY AND THRIFT

We are the richest nation in history. We have been made rich by the self-discipline of savers, who today are a tiny fraction of the American public. American households 25 years ago saved over 10% of their discretionary income. Today, American households save nothing. They borrow instead. See the chart from the Grandfather’s Economic Report: http://GaryNorth.com/public/3759.cfm

In 1983, the American economy was recovering from the worst post-war recession, the result of the wildly inflationary policies of the Federal Reserve in the 1970′s, made possible by Nixon’s abandoning of the gold exchange standard in 1971. When Paul Volcker’s FED stopped buying Treasury debt in late 1979, the recession was guaranteed.

In hard times, Americans used to save at high rates. Today, after 17 years without a major recession, they plead poverty.

“We just can’t save any more. We’re too poor!”

As recently as 1999, academic economists and mutual fund salesmen said rising stock prices made saving irrelevant. The new technology would make us rich. Greenspan was one of the loudest cheerleaders for this nonsense. The new technology has brought us prosperity. His most famous speech to this effect was delivered on January 13, 2000:

http://GaryNorth.com/snip/610.htm

Then, when the stock market bubble burst, eight weeks after his speech, the economists sang a new tune: rising housing prices would make us all rich. That bubble popped in 2006, much to the surprise of the economists.

Now, nobody says what will make us all rich. But serious economists have known ever since Adam Smith’s “Wealth of Nations”

(1776): thrift.

The productivity of capitalism has always been based on two
things: (1) the public’s willingness to save and (2) entrepreneurs’ willingness to bear the uncertainties of the future. Savers have funded entrepreneurs, and the result has been unprecedented economic growth for over two centuries.

Americans who are in the bottom 10th of income distribution live better today than kings lived in 1800. They have better health care, cheaper entertainment, cheaper books, longer life expectancy, air conditioning, central heating, and much more.

This has come as a result of the private property system, the future-orientation of a broad mass of savers, and the willingness of entrepreneurs to invest their time and money to meet the wants of consumers in the future.

All three are under attack today. The whiners are looking for victims. Congress will find them. That is what Congress does. This is its specialty in the social division of labor.

THE RECESSION

The economy is probably in a recession. I believe this recession will get worse.

The reason why we are in a recession is that Alan Greenspan’s Federal Reserve System pumped fiat money into the economy, beginning in June 2000, and continued to pump in money at escalating rates until mid-2002. Then the FED slowed somewhat, but not enough. When Ben Bernanke came in as Chairman in February 2006, he ended the still high rate of monetary inflation — his legacy from Greenspan. As a result, the American economy has slowed down sharply.

It was the prior monetary inflation by the Federal Reserve System that led to this recession. Recessions are caused by prior monetary inflation. This is the insight of Austrian School economics, and it is by far the most hated insight of Austrian School economics. The politicians hate it, the rival schools of economics hate it, and the voters hate it, to the extent of the voters suffer from the results of the original policy and do not blame the FED.

People want subsidies. The government cannot pay for the subsidies. It has no productive assets. It only has a gun. It can tax, but this creates resistance. So, part of the subsidies have come from the Federal Reserve System, which creates money in order to lower short-term interest rates to stimulate a boom or prevent a bust. These lower interest rates lure businessmen into starting projects for which there is insufficient capital saved by the public. These low rates also encourage borrowers to take on debt that they will not be able to afford when the recession hits, or when interest rates rise, or both.

We are trapped in a crisis created by the Federal Reserve System. We must now pay the piper, but nobody wants to pay.
Borrowers don’t want to pay. Lenders don’t want to suffer the losses that they are going to suffer because borrowers are not going to repay all of their loans. Politicians don’t want to suffer the consequences at the polls at the next election.

Voters don’t want to suffer the consequences of unemployment.

So, everybody looks for a legal gun.

Everybody wants to have a gun to stick legally in the belly of the other person, in order to force that person to pay his “fair share” — higher than the voter’s — to bail out the system, which is the joint product of (1) the central banks of several countries, (2) the United States Congress, (3) the present Presidential administration, (4) the fractional reserve banking system, and (5) tens of millions of American voters who demanded something for nothing and now face getting nothing for something.

Recessions expose the true costs of the politics of plunder.
Voters are committed to the politics of plunder, and they don’t want the lunacy exposed. They want the other guy to pay for their mistakes. So, Graham is correct: we have become a nation of whiners. But we are whiners with a gun: civil government.

Specifically, voters whine about the costs that economic liberty imposes on people who have taken risks that were greater than borrowers and lenders supposed. People don’t want to bear the costs of their own actions. So, they go looking for someone with a fat pocketbook. They want Congress to stick a gun in his belly. Congress is usually quite willing to do this. An economic recession makes Congress even more willing.

Twenty years ago, with respect to cutting government spending, Graham quoted the title of an old gospel song:
“Everybody wants to go to heaven, but nobody wants to die.” This is exactly the case today. Everybody wants stable money, but nobody wants a recession. Everybody wants government benefits, but nobody wants to pay the taxes. Everybody wants an economic boom, but nobody wants the inevitable bust.

WHAT DID THEY EXPECT?

Recently, I received a letter from a woman who took umbrage at the fact that I publicly referred to the fact that Americans have ceased to save. She wrote this:

“You seem to think the problem is that Americans can’t
save money or budget properly, and that we will be
forced to cut our budgets to deal with rising energy
prices. Well, you can’t save money if there’s none
left over after paying bills. I know my budget, but it
doesn’t mean anything if I do not have enough cash.
Right now, if I pay all my utility bills on time, I
have barely enough for food (or for some medicine, but
not both). I’m handicapped and on a fixed income.
And when I go shopping–which I do only once a week to
save gas–I see 10-30% inflation, not 3%. My biggest
worries right now are (1) the electric company in
Pennsylvania is asking for an increase of 50-75%, and
(2) I know the cost of my propane heat will also go up
accordingly. That will leave me with two winter bills
guaranteed to wipe out my entire monthly Social
Security check, even though I will close down most of
the house and live in just two rooms. I will be eating
bark if I manage not to freeze to death.”

She is on Social Security. She is a ward of the state. She lives on the taxes paid by others. Yet she complains mightily.

She resorts to rhetoric of poverty — eating bark. Anyone this skilled at self-pity will always find a way to get by through the kindness of strangers — and the voting booth.

I fully understand her current problem. A tiny handful of Americans are handicapped. She has no reserves. This is a terrible situation to be in. This is the famous rainy day she was supposed to save for. She was not content to tell me her problem. She spoke on behalf of middle Americans in general.

“Most of my neighbors are very frightened, even the ones
with jobs. I don’t think economists–and certainly not
the politicians–have a clue as to what Middle America
actually contends with. And Phil Gramm, who thinks
this is all in our minds, is a perfect example of a
government lackey who ought to be facing a firing
squad.”

Their problem, like hers, began decades ago when they did not adopt a systematic program of saving. Their bad habit has now caught them, with lots of help from the Federal Reserve System. My generation was taught to save for a rainy day. This generation did not heed that ancient advice. A level-3 hurricane is approaching, and they say they cannot save.

Why did they refuse to save when the good times were rolling?

I replied to her by stating the obvious: as this recession accelerates, she and tens of millions of other non-saving Americans are going to cut their budgets. They will have no choice but to cut their budgets. They will be losing jobs, suffering reduced income, and paying higher prices than they want to pay, at least until energy prices fall in response to the recession. In other words, she is going to have to cut her budget in the near future.

Why doesn’t she cut her budget today? She’s going to have to cut back in those sections of her household budget which will have to finance the rising cost of energy, the rising cost of food, and anything else that is still rising in price. But she says she just can’t.

Yes, she can. And she will.

“I just can’t save!” No; they just won’t save, and haven’t saved, at an accelerating rate for 25 years. Members of each income group refuse to move down to the one below them and save the difference. They deeply resent having to pay for their own unwillingness to budget. They all want to be Congress.

They refuse to count the costs of their own unwillingness to save. They are present-oriented people, meaning lower-class people. They are not willing to save, because they think that Uncle Sugar is going to bail them out.

UNCLE SUGAR SPEAKS

On Sunday, Uncle Sugar’s economic spokesman, Secretary of the Treasury Henry Paulson, announced exactly that. He is going to recommend to Congress that Congress put the entire American electorate at risk for the failure of Fannie Mae and Freddie Mac.

Once again, a politician’s appointee, a member in good standing in the investment bankers’ club (Goldman Sachs), to whom insolvent debtors owe their enormous debts, comes to the public in the name of the senior politician and says that Congress has just got to bail out the bad decisions of short-sighted lenders and short-sighted borrowers, of whom Congress is chief.

He announced this on a Sunday, which means that the government was convinced that a collapse of the stock market was quite possible on Monday morning. This was a replay of the Bear Stearns’ bailout announcement.

A Sunday announcement is the sign of total panic in Washington. It is the sign that the politicians at the highest level do not want the housing market to collapse. This is an election year, and voters who suffer housing losses tend to vote for the rival party.

His announcement may have averted the bankruptcy this week of these two overleveraged, scandal-ridden institutions, but it did no good for the banking sector. On Monday, the banking sector suffered its sharpest one-day decline since 1989: http://GaryNorth.com/snip/606.htm

Washington Mutual, already considered by many as the next bank to follow IndyMac, fell by 35%. It was not alone. National City Bank was down 25%.

Over the past year, the Standard & Poor’s Bank Index has fallen by two-thirds. This chart ought to send chills down the spines of every stock market investor. It was at 400 a year ago.

It is under 150 today: http://GaryNorth.com/snip/609.htm

Banking is the central institution in the modern economy.
American banking is in a bear market of unprecedented severity.

The Secretary of the Treasury can issue lots of weekend assurances, but they no longer have much effect.

THE TOOTH FAIRY IS ARMED AND DANGEROUS

Americans believe in the tooth fairy. The tooth fairy comes in several costumes. One is the costume of the Federal Reserve System, which promises to make available fiat money in order to bail out lending institutions that lent money at interest rates that were too low, because the Federal Reserve System under Alan Greenspan forced down these interest rates.

If the FED refuses, then the central banks of Asia and Russia are supposed to rush to our rescue and buy our debt, so that we can continue to spend $850 billion a year more than we produce. They are supposed to create more money and buy dollars and use the dollars to buy more Freddie Mac and Fannie Mae bonds.

Then there is the tooth fairy of Congress. It is accepted on faith that Congress can create wealth out of nothing, simply by taxing the rich.

The rich also want their bailout, so they applaud Paulson and Bernanke. They continue to buy the bonds of Fannie Mae and Freddie Mac. Freddie issued $3 billion worth yesterday. It found takers, as a result of Paulson’s suggestion. They may even be willing to buy shares of these two doomed enterprises, although the initial rally ended within an hour. They assume that they can kick the can down the road for another quarter.

The voters agree with them.

Everybody wants the bailout, but nobody wants to pay. Phil Gramm was right years ago, and he is correct today. He has put his finger on the pulse of America, and the pulse is still strong. He then listens to what Americans are saying, and he hears endless whining. All of this is the result of the same phenomenon: everybody expects the other guy to pay for his mistakes. Everybody expects to keep all of the profits from his own wild speculation, such as borrowing money at below-market interest rates, and then, when his plans blow up in his face, he whines. If politicians don’t listen, he screams.

Screaming catches the attention of the incumbent administration. It catches the attention of Congress. So, the Secretary of the Treasury says that he will ask Congress to put the entire country on the tab for Freddie Mac and Fannie Mae.

The public cheers. The media cheer.

This is why the financial crises never end. We say we want them to end. We really do, but only at a below-market price.
Everybody wants to go to heaven, but nobody wants to die. So, we insist that the politicians and the Federal Reserve System kick the economic can down the road for another quarter or year. The bills mount up. We expect to be able to pay off those bills by telling the rich to pay them off. But the rich are not going to pay them off. The middle class will not pay them off.

The Federal Reserve System will pay them off. The FED is the ultimate guarantor of the debt system, the lender of last resort in an international economy based on debt. The Federal Reserve will create sufficient funds to buy the bonds, the stocks, and the large institution assets that are falling in value. When it runs out of Treasury debt to sell or swap — possibly next year — it will use fiat money to make the purchases. This is what it has always done; this is what it will continue to do.

The public believes in something for nothing. That is, the public believes in the tooth fairy. The only question is: Who is the preferred tooth fairy? That depends on who the preferred target is into whose belly Congress is expected to stick its collective gun.

The most important investment decision you can make is this:
avoiding Congress’s gun. Congress wields the gun, and its members constantly are in search of solvent bellies. Politics is the art of holding the gun and thereby avoiding becoming the target. There is no question that both parties are running this year on the question: “Whose belly?”

Ultimately, the Federal Reserve will create the money to pay off the debts and keep the institutions officially solvent. This will lead to the destruction of the dollar. This is just a matter of time. We know this, because nobody is willing to accept the painful consequences of prior inflations and prior decisions made in terms of those inflations. Nobody is ready to pay the piper. This means that everybody plans to pay his personal piper with fiat money.

We are in a period in which the Federal Reserve has stabilized the money supply. This has led to a recession, and the entire housing structure of the Western world is beginning to totter. The debts are about to overwhelm the capital system that has made available long-term mortgages at interest rates that are not sustainable.

THE MORTGAGE MARKET

In 2008, Freddie Mac and Fannie Mae have supplied 80% of all new mortgages written in the United States:

http://GaryNorth.com/snip/603.htm

They already hold or guarantee close to half of all U.S.
mortgages. Bloomberg estimates that Fannie Mae has issued $830 billion in bonds, while Freddie Mac has issued $644 billion. The total of bonds plus guarantees is over $5 trillion: http://GaryNorth.com/snip/604.htm

What this means is that the private mortgage markets, apart from the assumed government guarantee behind Fannie Mae and Freddie Mac, have ceased to provide mortgages at today’s low rates. The government is desperately afraid that without Fannie Mae and Freddie Mac, the free market will raise interest rates on mortgages. This will depress the market price of existing Fannie Mae and Freddie Mac bonds, which are held by all the major investment institutions, and by foreign central banks and foreign commercial banks. Already, over 20% of Freddie Mac and Fannie May bonds or guaranteed mortgages are held by foreigners, mainly by foreign central banks: $1.3 trillion. These institutions want assurances of repayment: http://GaryNorth.com/snip/602.htm

A rise in mortgage rates will drive the housing market into
a depression. Millions of additional homeowners will lose their homes. They will not be able to sell their homes to pay off their debts because new buyers will not be able to pay the higher interest rates in a free market mortgage environment.

This is why Treasury Secretary Paulson issued his Sunday afternoon emergency announcement. The government is desperate to save American housing, because if American housing prices truly collapse, the economy could move from a recession into a full-scale depression. The senior decision-makers fear this.

They fear it for good reason. The housing market has been the engine of economic growth in the United States for over a decade, and certainly since 2001. That engine has gone off the tracks.

The cars behind it threatened to follow. The government and the Federal Reserve System are desperately trying to get the engine back on the tracks.

Investors believe that Uncle Sugar, by sticking its gun into appropriate bellies, can bail out the housing system, and keep the recession from turning into a depression. Investors still have not panicked. Voters have not panicked. Congress is scared witless, and is likely to do whatever Paulson and Bernanke recommend. But the result is going to be another round of indebtedness which forces the Federal deficit even higher than it is today.

We are looking at a Federal deficit exceeding $500 billion in fiscal 2009, and maybe $700 billion or $800 billion, for years on end. The only reason why American investors should buy such Treasury debt is that they think all the rest of the markets are going to fall with such rapidity that it still will pay to own Treasury debt. For a time, this will be true. But at some point, it is not going to be true.

When will that be? When the Federal Reserve will have to intervene to serve as the lender of last resort. At that point, the inflation scenario will return with a vengeance. I think this will be before the Presidential election of 2012. I think whoever is President during the next four years is going to go through the economic wringer.

CONCLUSION

What about you? What is your personal solution? One thing is crucial: saving. You have got to cut your spending now, since you are going to have to cut it over the next year anyway. Get used to cutting it now. Save your money. Put it into the bank.

The FDIC insures your bank, and for a few more months, the FDIC will still have Treasury debt to sell in order to bail out failing banks. It may even be able to survive three or four bank failures, given the fact that the failure of IndyMac over the weekend depleted FDIC assets by around 10%:

http://GaryNorth.com/snip/600.htm

The problem is, one estimate places the number of banks that may fail over the next three years at 300. This is up from a “mere” 150 in February: http://GaryNorth.com/snip/601.htm

Where will the FDIC get more assets after it runs out of Treasury debt certificates to sell? The FDIC has very limited resources to deal with the magnitude of the banking crisis that has begun to unfold.

Who will bail out the FDIC? Who will ensure the insurer?
This question will have to find an answer sometime over the next 12 months. The answer will determine the shape of the economic recovery, so-called. It will force the hand of the Federal Reserve System. The clock is ticking louder and louder.

You had better decide now what you’re going to do then, since you’re not going to want to have to make a decision of how to restructure your family budget after you have lost your job, or after your investment portfolio has fallen by 20% or 30%.

Start making the revisions now.

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Gary North’s Economic Edge™

The Economic Edge, a publication of The American Vision, is emailed twice per week.

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SHOOT THE MESSENGER?

By Dr. Gary North 
for Gary North’s Q&A forums: www.GaryNorth.com

We have all heard the phrase,”Shoot the messenger!” We hear it in the context of someone who has brought bad news. The critic who warns against shooting the messenger implicitly recommends that we not impose negative sanctions against a person who brings bad news, simply because the news is bad. That seems right to me.

The relevant issue is whether or not the information is accurate. We want a steady supply of accurate information. We also want it presented in such a way that we will recognize the importance of this information, and then act appropriately in terms of it. We want both accuracy and motivation. It does not do us any good to know that something is true unless we act in terms of what we know to be true. We need motivation.

We also want to reduce the supply of inaccurate information. We don’t want our circuits overloaded with piles of inaccurate or irrelevant information. Also, we don’t want to be burdened with inaccurate information which is packaged in an effective, highly motivational way. We don’t want to be persuaded to do something inappropriate with reality, which happens to be appropriate with respect to inaccurate information.

We want to encourage the flow of accurate information, and we want to discourage the flow of inaccurate information. In other words, we want to impose positive sanctions on those who bring us accurate information, and we want to impose negative sanctions on those who bring us
inaccurate information.

We dare not abandon the principle of “shoot the messenger.” To abandon this principle would be to open ourselves to an even greater supply of inaccurate information. This, we presumably do not want.

We therefore have to make a decision as a society. We have to decide three things: which messenger to shoot, why, and who should shoot him. Entire civilizations are constructed in terms of competing answers to these two questions.

SPECULATION

During the international housing bubble, which began in the mid-1990s and accelerated after 2001, nobody complained about speculators running up the price of housing. That was because anyone seeking a mortgage to buy a house was a speculator. He was trying to lock in the price of an asset with borrowed money. This is the classic mark of a speculator. But, since almost everybody was involved in this form of speculation, with the exception of renters, nobody criticized speculators, because so many people seemed to be benefiting from the speculation.

The housing bubble popped in 2006. People who bought homes after 2004 find today that they have lost money. Still, they don’t think of themselves as speculators who made a bad decision in entering a highly speculative market. Almost no one believed in 2005 that real estate had become a highly speculative market. I did, and I told subscribers that the market was overpriced, but there were not many people sounding the alarm in 2005.

We don’t hear criticism of speculators who caused the run up in real estate, and who therefore are to blame for today’s losses, because we are the speculators who did it. We have met the enemy, and he is us. So, we blame mortgage brokers, unscrupulous lenders, and similar people who provided the money to just about everyone who wanted to be a real estate speculator. We are like Flip Wilson’s Geraldine. “The devil made me do it!”

The person we should blame, Alan Greenspan, is Mr. Untouchable, so almost nobody criticizes him. If there is a devil who made us do it, it is Greenspan.

Today, the price of oil is twice that it was a year ago. The media are filled with reports by politicians, newspaper editorials, and common people complaining about the fact that speculators have driven up the price of oil. Everyone is upset, except those speculators who went long,because we all use gasoline. We don’t like paying more for the gasoline we use. So, we criticize speculators for forcing us to pay high prices for gasoline.

I think the oil market is similar to what we saw in the housing market after 2002. I think the energy market is a bubble. We are going to see a decline in energy prices in the same way that we have seen a decline in housing prices. What goes up will come down, unless the Federal Reserve System starts inflating in earnest. But, when we are in the middle of a bubble, and especially when we are in the latter phases of a bubble, most people think we have entered a new era. They think, “This time it’s different.”

There is no doubt that one of the factors in the rising price of energy is the fact that India and China are beginning to demand more oil. Hundreds of millions of people have gotten richer, and one of the things that newly middle-class people do is to buy a car. This should not come as a surprise to anybody.

There’s no question in my mind that, long term, the price of energy will increase. Entrepreneurs will seek out ways of cutting the cost of energy by discovering new ways to conserve energy on a cost-effective basis, and discovering new sources of energy. This is as it should be. If the price of energy did not rise, there would be much less motivation to discover new ways of saving energy and discovering new sources of energy.

This is the logic of the free market. When demand rises, prices rise, and there is no greater incentive for suppliers to seek out new ways to supply the demand than the hope of profit. It is a rational system.

But politicians who want to increase the power of the civil government over the public don’t like the free market system. That’s because the free market system solves problems effectively without many appeals to, or reliance upon, politicians. Politicians are generally irrelevant to the functioning of a free market system. Politicians don’t like to be irrelevant. They want to be highly relevant.

Most important of all, politicians want to be the people who hold the significant gun. One of the things that a gun is useful for is to shoot the messenger. So, any time that a politician can blame the messenger, he does. This increases voters’ confidence in politicians to hang onto the guns in order to shoot even more messengers.

Senator Joseph Lieberman has introduced legislation calling for restrictions on the creation of investment pools that invest in energy. He says that speculators are driving up the price of energy. He wants to keep them from driving up the price of energy. So, he wants more ammunition for the Federal government’s guns, which will be used to shoot the messengers.

Today, we see the Federal government seeking new ways to punish the greedy lenders who loaned money to people who brought homes that they could not afford. In other words, they want to shoot the messenger retroactively. We also see the same politicians considering legislation to use
taxpayers’ money to hand over to people who brought homes that they could not afford, so that they can stay in their homes. This is subsidizing people who listened to highly motivating messengers.

When the government subsidizes something, we will get more of it. This form of subsidy — retroactive bailouts — is called “moral hazard” by critics and “giving good people who made stupid decisions another chance” by proponents.

People who made these stupid decisions are (1) insolvent borrowers and (2) nearly insolvent multinational banks that lent them the money.

Note: the subsidy money that will go to insolvent borrowers will be used to make monthly mortgage payments to multinational banks. This fact is not mentioned by politicians who favor mortgage bailouts.

So, on the one hand, the government wants to put limits on highly motivating but supposedly crooked messengers (local mortgage brokers, and on the other hand, they also want to subsidize retroactively the people who listened to these highly motivating messengers.

I am not sure what message the politicians are sending. I know the message that I am hearing.”Politicians are dumb.” They do not understand economic cause and effect. So, they recommend policies that will both hamper and subsidize the same behavior. These are the sorts of people who supply government subsidies to the tobacco growers and then penalize companies that sell tobacco.

This goes on, decade after decade, and the voters never seen to figure out that politicians are economically dumb. They are worse than economically dumb. They are lawyers. They can vote themselves an endless supply of guns and ammunition.

We know who is holding the gun. The question is, who is it pointed at? Us.

SPECULATORS

Speculation is inescapable. Every time we forecast the future and then plan in our lives in order to meet this expected future, we are involved in speculation. Speculation is forecasting the future and then devising plans to deal with that future. It’s a simple concept. I suppose this is why Congress does not understand it.

A speculator who wants to remain a speculator very long does whatever he can to avoid influencing the market. The last thing he wants to do is to influence the market. The biggest single problem that a successful commodity speculator encounters is the fact that if word gets out that he is going to buy a particular commodity, other speculators immediately buy that commodity, and the profit opportunity disappears.

If you do not think I’m right about this, think about what Warren Buffett could charge subscribers for an e-mail newsletter that tells them in advance what stocks he plans to buy the next day. I think he could charge quite a bit. Frankly, I don’t think you or I could afford that subscription. But Warren is not going to offer that newsletter service. Does this surprise you?

The most important information that a speculator can get is accurate information about what the price of a commodity will be doing a specific period of time. A speculator does not make money by driving up the price of whatever it is he speculates in. He makes money by acting in advance of a price increase by purchasing the right to purchase a commodity during a specific time period.

The more leverage he can get by going into debt, the more money he will make if he guesses correctly and then sells his right to purchase the commodity to another speculator. In other words, a speculator is just like the person who wants to buy a house with 3% down instead of 20% down, and then sells the house later at a much higher price. The less he puts down today, the more money he will make on the transaction . . . if he guesses right about the price of the future house.

In the commodities futures market, it takes two to tango. For a speculator who goes long, meaning that he promises to pay money to buy a commodity in the future, there must be another speculator who goes short, meaning that he promises to sell a commodity at a specific price in the future. For every long there is a short. Whenever a speculator who puts his money on the line, and his credit on the line, in expectation of a rising price, there is another speculator who is doing the same thing in the expectation of a falling price.

In the commodities futures market, almost no one takes delivery of the commodity. The commodity futures market is a market of promises to do what almost nobody in that market ever does. It is speculation based on promises, not based on actual delivery. So, when somebody goes long in oil futures, he does not remove any oil from the market. The supply of oil is in no way diminished. I don’t think the general public understands this. I am absolutely sure that 98% of the members of Congress do not understand it.

I ask: “In what way do speculators drive up the price of oil?” For each speculator who is betting on an increase in the price of oil, there is another speculator betting on a decrease in the price of oil. There is still the same quantity of oil available for consumers to buy.

As I have said, a speculator makes his money by accurately predicting the direction of the price of a commodity and then putting his money and his credit where his prediction is. If he guesses correctly, he makes money. If he guesses incorrectly, he loses money. In every commodities futures contract, one of the participants is going to make money, and the other participant is going to lose money. The only participant who consistently makes money is the book for who sells them the contract.

Then what determines the prices of commodities? Consumers. Consumers compete against each other by building for the final output of a particular commodity. When you go to the gas station and fill your car’s tank, you are a final consumer of oil. You are in competition with other consumers all over the world who are deciding whether or not to fill their gasoline tanks. Those who do are your immediate competitors. Those who don’t are not yet your immediate competitors.

Here is the rule: high bid wins. This is the most fundamental rule of the free market. The free market is a gigantic auction, and the prevailing rule of an auction is this: high bid wins. We understand this with respect to auctions. If we applied this understanding to the entire free market, we would make very few intellectual mistakes about economic cause and effect.

The problem is, this principle applies in politics in a completely different way. It applies to voting rather than to economic production. The currency of politics is votes. The currency of the free market is digits (money). We consumers bid against each other for goods and services produced in the free market. We use digits to compete against each other. In order to get our hands on digits,
we must be productive (unless we are politicians).

What a speculator wants to know above all else is what the price will be in a specific period in the future for a specific commodity. He wants to know what the high bid will be for that commodity at some point in the future. He does not make his money by bidding up the price of the commodity above what consumers will be willing to pay for that commodity at some point in the future. He makes his money by purchasing the right to buy a commodity at some point in the future. His goal is to pay less today than what consumers in the future will be willing to pay. He is trying to lock in his purchase price today so that he can sell that right to some speculator in the future at a higher price than is paying today.

It is true that speculators can drive up the price of the commodity. But this process is not understood. Producers who buy a particular commodity in order to sell to consumers later use the information provided by competing commodity speculators to determine what the price of the commodity really ought to be.

If they see that the price of a commodity is rising in the futures market, they may buy more of this commodity now. If lots of producers do this, the price will rise. The way that the futures market drives up prices is by alerting actual producers to changed conditions in the market. The producers drive up prices because they expect consumers to drive up prices.

The price which is determined moment by moment on the commodity futures market is the message. The messenger is the speculator. Producers who use the futures market to find out the price of a commodity make an assumption: the best source of information regarding what consumers will be
willing to pay in the future is the commodities futures market. The commodities futures market is the most efficient, least expensive, most reliable source of accurate information regarding the future price of any traded commodity. Producers structure their plans on this assumption.

Congress thinks they are all wrong. Congress thinks Federal bureaucrats should manage the information-delivery system.

One more time: a speculator does not want to buy the right to purchase a commodity in the future if today’s price of the commodity is higher than what consumers, by competing against each other, will be willing to pay for that commodity in the future. If he believes that today’s price is higher than what consumers will be willing to pay in the future, he goes short. He buys the right to sell the commodity at a fixed price sometime in the future, on the assumption that the price of the commodity in the future will be lower than the price in he agrees to today.

He makes his profit on the difference between the price that he agrees to today to sell that commodity in the future compared to the actual price for consumers will be willing to for it.

Most people do not understand any of this. Yet they understand very similar transactions in their own daily experience. Here is an example. A man who makes his living by cleaning swimming pools may think that the economy is going to turn down, and demand will decrease for swimming pool cleaning services. So, he tries to get his existing clients to sign up for a year’s worth of swimming pool cleaning services at a discount. In other words, he goes short in the swimming pool cleaning futures market. He gets paid today to deliver services tomorrow. If the price of those services drops because of the recession, he keeps the money. He makes more money than if he had sold his services in a declining market.

I suppose that if the news media ever discover that swimming pool owners are going into the market to sign such contracts with swimming pool cleaners, Joseph Lieberman is going to try to get legislation passed to stop swimming pool owners from making these contracts. It’s clear that such owners are driving up the cost of swimming pool cleaning services, to the detriment of the People.

You think yourself, “that’s silly. Joe Lieberman won’t introduce that sort of legislation.” I add: “Not unless the media pick up the story.”

We can easily see that the whole concept is preposterous when applied to swimming pool cleaning services. We think that the commodities futures market is somehow different. It isn’t different. This same principle governs both markets: high bid wins. In both markets, it is competition on the consumers that sets the price. In both markets, it is the accuracy of the forecast that is crucial to profitability.

CONSEQUENCES

When the government intervenes to shoot the messenger, this increases the supply of inaccurate information. The free market, through the profit and loss system, shoots lots of messengers every day. It shoots millions of them every day. It doesn’t shoot them fatally in most instances, but it shoots them daily. It shoots them in the foot, mostly. Messenger by messenger, shot by shot, messengers who deliver inaccurate information are removed from the message-delivery system. This is as it should be.

It’s different with the government. The government doesn’t like the free market’s message-delivery system. Politicians want to place restrictions on the operation of this system. They want the system to become dependent on whatever the politicians tell the bureaucrats to permit. The politicians want to set the general rules regarding the shooting of messengers. They do not trust the profit and loss system to do this job efficiently and accurately over time. They assume that the profit and loss system is incapable of distinguishing accurate messengers from inaccurate messengers.

When the government interferes with the message-delivery system, it interferes with our ability as consumers to decide which information is accurate and which is inaccurate. In interferes with our ability to reward those messengers who deliver accurate information and penalize those messengers who deliver inaccurate information. It undermines the fundamental principle of the free market: high bid wins. It substitutes a different principle: submission to winners of contests for votes. It substitutes the principle of high bid wins in elections for high bid wins in the market.

If the government is successful in restricting speculators from entering the market place and competing against each other to determine what future consumers are going to pay, one thing is for certain: future consumers are going to pay more. They’re going to pay more because the information-delivery system is what producers rely on to estimate the cost of production. They will be hampered by the regulations imposed on speculators by the politicians. This will raise the cost of production, and it will therefore reduce the number of competing suppliers. With fewer suppliers, consumers are going to pay more.

If some speculators are convinced that the price of oil is going to go up, let them put their money and their credit where their mouths are. They cannot do this unless they find other speculators who are equally convinced that the price of oil is going to go down. May the best speculators win!

The enormous benefit to the consumer of the commodity futures market is that it enables producers to find out what they ought to pay, wholesale, to buy these commodities. Then they produce goods for consumers. Do we think we will be better off if the producers who compete for our money are unable to access better information?

Joseph Lieberman thinks so.

There is no more accurate source of price information than the commodity futures market, precisely because most speculators can and usually do lose money on their speculations. The general estimate is that fewer than 5% of all commodity futures traders make money long-term. The bad ones are eliminated from the market by competition. Because of the high leverage involved in these markets, the bad ones are eliminated very fast. The message-delivery system shoots poor commodity speculators with abandon. It doesn’t need Joe Lieberman to get into the business of shooting messengers.

If politicians interfere with the commodity futures market, as it appears likely that they are going to do, the result will be higher prices than what would have prevailed if they had stayed out of the regulatory business.

Then, when the bubble bursts, prices will be lower than what otherwise would have prevailed. Is this good? No. If prices are lower than what consumers would have paid, this will reduce the production of new forms of energy, new ways of delivering energy, and new ways of conserving energy.

The point is, consumers should determine the price of energy through competitive bidding on an open market. Consumers are assisted in this process by speculators. Speculators put their money where their forecasts are, and the result, through intense competition, is accurate information.

Anyone who thinks that the Federal government ought to interfere with this process is saying, in principle, that he thinks that government-salaried bureaucrats, who do not put their own money on the line, are the most competent people to devise the rules governing the process by which the future price of a commodity ought to be. I do not share their optimism regarding Civil Service- protected bureaucrats.

CONCLUSION

The journalists who write the stories about commodity speculators driving up the price of oil are as ignorant as Congress. The difference is, journalists don’t hold guns. They do not point these guns at the bellies of speculators who are attempting to make money by forecasting future onsumer demand.

My view is that it is safer to let speculators deal in pork bellies than it is to let Congress deal in speculators’ bellies. They will shoot the message system.

I believe we are in a recession. So does Warren Buffett. I think it will last longer than the typical
recession has lasted. So does Warren Buffett. I think this recession will be worldwide. I think it will lower the demand for commodities. This will include the price of energy. The recession will drive down energy prices.

Joseph Lieberman will drive up energy prices. Frankly, I prefer a recession to Joseph Lieberman.